Rates: The Long Way Home

Opportunity knocks as Fed rate cuts are likely to steepen the yield curve.

December 23, 2019

This Rates sector report is excerpted from the Fourth Quarter 2019 Fixed-Income Outlook.

The third quarter brought a fair amount of uncertainty and volatility to global markets, primarily driven by trade tensions, political developments, and mixed signals for global growth. Domestically, the U.S.-China trade war weighed on both consumer and business confidence, though GDP growth and job gains were resilient. The Fed acknowledged the emerging risks of a more pronounced global slowdown and moved to lower the federal funds rate by 25 basis points at its October meeting, although not without several dissents. The decrease in rates marked the third time that the Fed lowered rates, taking the target range to 1.50–1.75. In mid-September, economic activity and trade wars were briefly overshadowed by funding market dislocations, which highlighted the reduced supply of short-term liquidity brought on by the decline in excess reserves, corporate tax day, and increasing Treasury financing needs. The magnitude of the market dislocation seemed to catch the Fed by surprise and led to the quick implementation of ongoing overnight and term repo operations to calm markets. The Fed also began purchasing Treasury bills at a pace of $60 billion per month to increase the supply of reserves. This will continue into the second quarter of 2020.

The third quarter delivered another strong performance for the U.S. Treasury market. The yield curve bull flattened, and Treasury yields declined by 15–40 basis points across the curve. So far this year, front-end yields have declined by 85 basis points and longer end yields have declined by 100 basis points. During the quarter, the Treasury market generated a total return of 2.4 percent, bringing the yearly total to 7.7 percent. The 20+ year Treasury market has delivered equity-like total returns of 20.2 percent year to date. The Agency market produced a total return of 0.8 percent for the quarter and 6.0 percent year to date.

20-Year Treasurys Delivered Equity-Like Returns Year to Date

The 20+ year Treasury market has elivered equity-like total returns of 20.2 percent year to date.

20-Year Treasurys Delivered Equity-Like Returns Year to Date

Source: Guggenheim Investments, Bloomberg. Data as of 9.30.2019.

Looking ahead, we believe the yield curve is likely to bear steepen further as markets price in a successful mid-cycle adjustment by the Fed. Nevertheless, market volatility will likely continue, creating opportunities to find attractive yields in longer lockout callable Agency debt and fixed-rate bullet Agency bonds.

Mid-Cycle Easing or Recession Easing Cycle Have Both Led to Steeper Yield Curve

We believe the yield curve is likely to bear steepen further as markets price in a successful mid-cycle adjustment by the Fed.

Mid-Cycle Easing or Recession Easing Cycle Have Both Led to Steeper Yield Curve

Source: Guggenheim Investments, Bloomberg. Data as of 10.29.2019.

Note: “Rates” products refer to Treasury securities and Agency debt ecurities. Treasury and Agency returns are represented by the Bloomberg arclays Treasurys index and the Bloomberg Barclays U.S. Agency index, espectively.

—Connie Fischer, Senior Managing Director; Kris Dorr, Managing Director; Tad Nygren, CFA, Managing Director

Important Notices and Disclosures

This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.

Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating rate senior secured syndicated bank loans and other floating rate securities involve special types of risks, including credit risk, interest rate risk, liquidity risk and prepayment risk. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited, and Guggenheim Partners India Management.

©2019, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.


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